Alistair Darling has announced a £20 billion package of tax cuts designed to boost the British economy in his pre-Budget report, balancing them with a tax increase for higher earners.

The Chancellor told Parliament that VAT - the 17.5 per cent levy on most goods and services - will be reduced to 15 per cent from Monday for 13 months. He said the move was the equivalent of passing £12.5 billion to consumers, and called on retailers to pass on the cut in full.

He has also announced a new top band of income tax, meaning those earning £150,000 will pay 45p from every pound they earn, to be implemented after the next election. He has also halved the personal allowance for those earning more than £100,000, which had been higher than for others. He said: "The higher rate will only affect the top one per cent of incomes."

He announced that national insurance contributions are to be increased by 0.5 per cent for all taxpayers, but said that no one earning less than £20,000 would lose out because the personal allowance that can be earned before contributions begin will be raised to match that for income tax - £6,035.

The Chancellor also announced that the £120 rebate for basic-rate taxpayers – brought in earlier this year to prevent a rebellion over the 10p tax debacle – is to be made permanent.

Mr Darling also confirmed that Government borrowing is to soar and confirmed that the country will fall into recession next year. He said that borrowing would reach £78 billion this year - approaching twice what was originally budgeted for - and will reach £118 billion in 2010.

He said that the economy will shrink by up to 1.25 per cent next year, but predicted that it will emerge into growth again by 2010.

The Chancellor said interest rate adjustments were no longer enough to stimulate the economy and that tax cuts were necessary. He said: "We need action now to boost economic activity".

He said: "Our economy cannot insulate itself from the global economic turmoil," but - to howls of derision from the Conservative benches - insisted: "the UK economy faces the turmoil in a position of relative strength."

Referring to a Conservative accusation that the Government "did not fix the roof when the sun was shining," Mr Darling added: "We did fix the roofs that needed fixing, we fixed the roofs of schools and hospitals throughout the United Kingdom."

He accused the Tories of having a "sink or swim" attitude, and of being prepared to force struggling people to fend for themselves amid the coming recession.